acheiving discipline, part 2

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    Three decisions

    Now we understand and respect the decision making control we have, there are no excuses. In trading, discipline should be used at many points in a trade. First, we decide on an entry. We should always be considering the pain possibilities in this process, many people focus only on the happiness part, ie ‘how much will I make?’. Before we enter the trade, we have two other decisions to make. One is our stop-loss. We need to do all 4 steps for the stoploss, then decide on an exit strategy using the 4 steps again. It sounds like a lot of work, but in time you will do it subconsciously and quick. “Plan the trade and trade the plan”. This means know what you will do before you need to do it, and cover every scenario. Your mind is unreliable when it has to make decisions in a hurry. Make the decisions when you are calm and have time, enact them when need be without thought. This ensures clear, calm, stress-free thinking and no mistakes.
    Emotion is your worst enemy. Fear and greed easily replace pain and happiness in the decision process when inaction is taken, but with less control. Fear especially is uncontrollable, so keep control in the decision making process by acting before fear (or greed) become a problem.

    Let us go through an example trade. Assume RIO has been in a downtrend, and we see there is support at 2900.

    Entry. We think RIO will provide us with short-term happiness if we buy RIO at 2900 and it rallies. Our short-term pain is that RIO will fall under 2900, causing us to stop out, and then rally. Our long-term happiness is watching RIO go up and up for months. Our long-term pain would be if we bought at 2900 and did not stop out, and RIO kept falling, causing us a large loss. Lets assume we weigh these thoughts up and decide to take the risk.

    Stop-loss. Support is 2900. Our trading rules tell us to buy on support and stop out if below support. This makes our decision easier, as there is a clear-cut difference between under or above support. The only decision we need to make is how much lower do we want the stop. Our short-term pain is that we set our stop too close. Our short-term happiness is we set it close and RIO breaks down. Our long-term pain is that we set it too far away and lose more than necessary. Our long-term happiness is we set it far away and RIO breaks down slightly then rallies, in which case we are safe. Lets assume then that we decide to set the stop at 2890.

    Exit. We enter at 2900, and are taking a risk, so we should not aim for a low return. We could use one of a hundred exit strategies, such as a 10% gain, moving average cross or a count back line. Each will have its own pains and happiness, namely giving a return different to other strategies. The pain is choosing one that gives the lowest return, and the happiness is choosing the one that gives the best return.

    Now we have our three decisions made, we enter the trade and trade the plan, calm and collected. We do not get excited when we win, and we do not get upset when we lose. If we cannot control our emotions and keep them well clear of our thinking, they will corrupt our decision processes. This is a skill that is learnt in time.


 
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